This invention relates to systems for creating and managing securities. More particularly, this invention relates to systems for creating and managing securities that are collateralized by mortgage obligations.
The mortgage securities industry is the largest financial business in the United States and consists primarily of products related to mortgage loans on residential and commercial properties. The great majority of residential mortgage loans are extended to individuals for the purpose of financing their primary or secondary place of residence. Mortgages are loans with a principal amount that is usually scheduled to be gradually paid-off over an extended period of time, such as 15 or 30 years. The mortgage loan carries an interest rate that is periodically (usually monthly) applied to the remaining principal balance of the loan. The "scheduled" periodic payment usually consists of the interest owed on the outstanding balance for the previous period plus some amount of principal which reduces the outstanding balance of the loan.
A characteristic of the current mortgage industry is that most of the money for residential mortgages is ultimately provided by institutional investors--not by the banks or mortgage bankers who usually arrange the mortgages for homeowners. Once a group of mortgages with similar terms has been arranged, they will often be packaged into a single unit called a mortgage pool and sold to institutional investors. Most residential mortgage loans issued in recent years have ended up as components in large mortgage pools that were ultimately resold to institutional investors or to investment bankers that repackage them into other forms of mortgage-backed securities.
For example, a mortgage lender may collect several million dollars of 30-year mortgage loans that it originates and place them into one package. Whereas the individual mortgages may carry interest rates of 8.85% to 9.30%, the interest rate on the package will usually be a single fixed rate such as 8.50%. The difference between the interest paid on underlying loans (the "gross coupon rates") and the interest rate paid on the package (the "pool rate" or the "net coupon rate") is usually retained by the original mortgage lender as a fee for arranging the mortgage and for continuing to service it (i.e., collect payments, perform bookkeeping, etc.).
Currently, the great majority of mortgage loans and mortgage pools are repackaged and restructured before they are ultimately sold to investors. The most common device for this is the collateralized mortgage obligation ("CMO"). The procedure for creating a CMO is as follows:
(1) An issuer/underwriter purchases a large amount of mortgages or mortgage pools--usually $250 to $500 million in value. This is the collateral for the CMO. PA1 (2) The collateral is deposited with a trustee who will thereafter receive the payments generated by the collateral and who will arrange payments to be made on new securities to be. issued. PA1 (3) The issuer/underwriter issues securities whose payments of principal and/or interest are collateralized by the payments of principal and interest that will be generated by the collateral. These securities are structured so that there will always be sufficient cash flow from the collateral (i.e., the mortgages) to fulfill the stated obligations of the newly issued CMO securities. The new securities are called CMO tranches, CMO bonds, or CMO classes. PA1 a) an interest-only security that receives 100% of the interest paid on the LA bond, PA1 b) an interest-only security that receives 100% of the interest paid on the LB bond, and PA1 c) two principal-only securities that have respective principal amounts and payment priorities equal to the above-described PRO securities.
Most CMOs are subject to real estate mortgage investment conduit ("REMIC") legislation designed to apply to various mortgage-related securities. Such CMOs are often simply referred to as REMICs. REMIC legislation and regulations provide for various tax, structural and other regulatory rules and regulations that govern the origination and structure of CMO/REMICs. The regulations govern what securities qualify as collateral for a CMO/REMIC as well as what securities may be issued by the REMIC.
The conventional securities that may be issued by a REMIC subject to the various REMIC restrictions are called "regular interests." It is these securities that are of greatest interest to the vast majority of investors. An important property of a regular interest is that any regular interest issued by a REMIC qualifies to be utilized as collateral for another REMIC. Each REMIC may issue any number of regular interests. In addition, each REMIC must issue one "residual interest" which receives whatever cash flow remains after the regular interests are paid.
At times the issuance of a desired regular interest security may be achievable only by utilizing several REMICS. In such a procedure the initial collateral from which the desired security is to be derived is placed into a REMIC which issues one or more regular interests. Some of these regular interests then serve as the collateral for another REMIC which issues other regular interests. This may be done several times until the desired regular interest security can be issued. When the creation of these several REMICS is done simultaneously, the procedure is referred to as a multistage REMIC.
At times, the REMIC regulations limit the ability to design and structure securities that would otherwise be attractive to certain investors. These restrictions are most restrictive in governing the amount and formulas for interest that may be paid on REMIC securities. These restrictions often prevent the creation of securities whose performance characteristics would make them most suitable as hedging vehicles for clients that own assets that could be significantly impacted by large or sudden movements in interest rates or mortgage prepayments.
In particular, the current and proposed REMIC regulations regulate what type of interest rates may be paid by a regular REMIC interest. For example, a regular interest may pay interest at a rate equal to: 1) a fixed rate of interest--e.g., 7.0%, 2) a recognized interest rate index or a multiple thereof plus or minus a fixed rate of interest--(e.g., 2 times the T-bill rate+1.50%), or 3) interest equal a fixed portion of the total interest on the collateral. An interest formula that is not directly provided for under the REMIC regulations is the payment of a variable percentage of the total interest on the collateral (e.g., the interest paid equals 25% of the total interest paid on the collateral if the T-bill rate is 5.0% or below, and equals 75% if the T-bill rate is above 5.0%).
Three popular securities that are often created within a CMO/REMIC are 1) principal-only ("PO") bonds which pay no interest and are therefore sold at a discount to their par amount (i.e., at less than the principal amount), 2) interest only ("IO") and similar bonds that pay little or no principal amount but are expected to pay a substantial amount of interest (relative to the principal amount if any), and 3) variable rate bonds that have an interest rate that varies with changes in some interest rate index. In general, the performance of these types of securities can be very volatile and the returns to investors in these securities may vary substantially depending on future interest rate levels and the rate at which the underlying mortgage loans are paid off by their homeowners. Nevertheless, these securities are attractive and useful to a variety of investors that utilize them to hedge their assets against interest rate risks or to achieve other performance objectives.
There are several drawbacks to these securities, however. Two of the drawbacks are that 1) the performance of these securities can be significantly affected in unanticipated fashion if the underlying mortgage loans are prepaid at either a faster or slower rate than expected, and 2) many potential institutional investors are prohibited from purchasing IO-type securities that have relatively little or no principal amount, because the investor is not promised even the return of the original investment.
Accordingly, there exists a need for a system to provide an investment vehicle whose performance is more predictable and controllable than conventional principal-only and interest-only securities. Further, there exists a need to meet investor objectives within current REMIC regulations.